Thanks to Colin over at Bankwatch for this one on losses suffered by the Bank of Montreal (BMO). At first sight it looks like just another bad day at the office for some traders – until you see the amount (currently estimated) as having been lost (CAD 680m – just over a quarter’s profit) and the bank’s reaction. This looks like a textbook case of how not to announce this to the market.

BMO seems to have broken a few of the rules on releasing bad news to the market. They started with a low loss number and, since then, have been increasing it. Once the reaction got too strong they now appear to have clammed up, cancelling press conferences is never a good idea.

The losses themselves are large – there is no other way to put it. As a result I suspect that the losses are not normal trading losses and that the two individuals who “no longer work for the company” were off on an adventure of their own with the bank’s money.

This always means that the losses are not “trading” losses properly so called – but operational risk losses.  They can only be called trading losses if the bank knew the positions were being run and were either managing them within normal procedures or had set up specific procedures to deal with these positions. To put it bluntly – if the bank knew these positions were out there and tolerated them then they were/are fools.

These sorts of positions are properly the domain of hedge funds, not commercial banks.

If, as I suspect, these positions were not under the control of the bank then that means that internal controls either were inadequate or broke down in several places (it must be several – good internal controls typically need several points of failure). Either way, look for some much better explanations over  the next few weeks  and / or some serious sackings.

The point? Large losses are almost exclusively operational risk breakdowns in nature. Banks typically focus on credit risk, regarding it as the core of their business. They are right that it is the core of the business, but how many banks have failed quickly by credit losses? What will blindside you and sink a bank is poor operational risk